Sharpton Fabricators Corporation manufactures a variety of parts for the automotive industry. The...

Sharpton Fabricators Corporation manufactures a variety of parts
for the automotive industry. The company uses a job-order costing
system with a plantwide predetermined overhead rate based on direct
labor-hours. On December 10, 2015, the company’s controller made a
preliminary estimate of the predetermined overhead rate for 2016.
The new rate was based on the estimated total manufacturing
overhead cost of $2,695,000 and the estimated 63,000 total direct
labor-hours for 2016:

Predetermined
overhead rate

=

$2,695,000

63,000
hours

=

$42.78 per
direct labor-hour

This new predetermined overhead rate was communicated to top
managers in a meeting on December 11. The rate did not cause any
comment because it was within a few pennies of the overhead rate
that had been used during 2015. One of the subjects discussed at
the meeting was a proposal by the production manager to purchase an
automated milling machine built by Central Robotics. The president
of Sharpton Fabricators, Kevin Reynolds, agreed to meet with the
regional sales representative from Central Robotics to discuss the
proposal.

On the day following the meeting, Mr. Reynolds met with Jay
Warner, Central Robotics’ sales representative. The following
discussion took place:

Reynolds: Larry Winter, our production
manager, asked me to meet with you because he is interested in
installing an automated milling machine. Frankly, I am skeptical.
You're going to have to show me this isn’t just another expensive
toy for Larry’s people to play with.

Warner: That shouldn't be too
difficult, Mr. Reynolds. The automated milling machine has three
major advantages. First, it is much faster than the manual methods
you are using. It can process about twice as many parts per hour as
your present milling machines. Second, it is much more flexible.
There are some up-front programming costs, but once those have been
incurred, almost no setup is required on the machines for standard
operations. You just punch in the code of the standard operation,
load the machine's hopper with raw material, and the machine does
the rest.

Reynolds: Yeah, but what about cost?
Having twice the capacity in the milling machine area won’t do us
much good. That center is idle much of the time anyway.

Warner: I was getting there. The third
advantage of the automated milling machine is lower cost. Larry
Winters and I looked over your present operations, and we estimated
that the automated equipment would eliminate the need for about
9,300 direct labor-hours a year. What is your direct labor cost per
hour?

Reynolds: The wage rate in the milling
area averages about $11 per hour. Fringe benefits raise that figure
to about $20 per hour.

Warner: Don’t forget your
overhead.

Reynolds: Next year the overhead rate
will be about $38 per hour.

Warner: So including fringe benefits
and overhead, the cost per direct labor-hour is about $58.

Reynolds: That’s right.

Warner: Since you save 9,300 direct
labor-hours per year, the cost savings would amount to about
$539,400 a year.

Reynolds: That’s pretty impressive,
but you aren’t giving away this equipment are you?

Warner: Several options are available,
including leasing and outright purchase. Just for comparison
purposes, our 60-month lease plan would require payments of only
$311,000 per year.

Reynolds: Sold! When can you install the
equipment?

Shortly after this meeting,
Mr. Reynolds informed the company’s controller of the decision to
lease the new equipment, which would be installed over the
Christmas vacation period. The controller realized that this
decision would require a recomputation of the predetermined
overhead rate for the year 2016 since the decision would affect
both the manufacturing overhead and the direct labor-hours for the
year. After talking with both the production manager and the sales
representative from Central Robotics, the controller discovered
that in addition to the annual lease cost of $311,000, the new
machine would also require a skilled technician/programmer who
would have to be hired at a cost of $56,000 per year to maintain
and program the equipment. Both of these costs would be included in
factory overhead. There would be no other changes in total
manufacturing overhead cost, which is almost entirely fixed. The
controller assumed that the new machine would result in a reduction
of 9,300 direct labor-hours for the year from the levels that had
initially been planned.

When the revised predetermined overhead rate for the year 2016
was circulated among the company’s top managers, there was
considerable dismay.

Required:

1. After seeing the new predetermined overhead rate, the
production manager admitted that he probably wouldn’t be able to
eliminate all of the 9,300 direct labor-hours. He had been hoping
to accomplish the reduction by not replacing workers who retire or
quit, but that would not be possible. As a result, the real labor
savings would be only about 4,200 hours-one worker. Given this
additional information, Calculate the net increase / decrease in
annual costs. (Round predetermined overhead rate to 2
decimal places.)

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